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HQ W563404

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March 3, 2006

RR:CTF:VS 563404 GG

CATEGORY: VALUATION

Mr. C.J. Erickson
Mr. Carl R. Soller
Cowan, Liebowitz & Latman, P.C.
1133 Avenue of the Americas
New York, NY 10036-6799

RE: Dutiability of Royalty Payments and Licensing Fees; Generra Sportswear Co. v. United States; Chrysler Corporation v. United States; Hasbro II Ruling.

Dear Mssrs. Erickson and Soller:

This is in response to your ruling request dated December 1, 2005, made on behalf of your client, [Company A]. The issue is whether certain licensing fees paid by [Company A] are additions to the price actually paid or payable. You request confidential treatment of certain information that you indicate represents proprietary pricing, origin and financial data. We grant your request and redact the confidential information that you have identified in your ruling request by the use of bold and italicized text.

FACTS:

[Company A] is an importer of products known as Thermal or Master Cyclers. These are electronic instruments that duplicate DNA and RNA by a process known as “polymerase chain reaction” (“PCR”). [Company A] purchases these items from a related German manufacturer, [Company B]. It then resells them to end users in the United States.

[Company B] obtained certain licensing rights with respect to the Master Cyclers by entering into a Thermal Cycler Supplier Agreement (“the Agreement”) with [Division C] in June 1997. [Division C] is a division of [Company C], which is incorporated in New York. [Company A] and [Company B] are not related to [Company C] or, consequently, to its division.

The license rights granted by [Company C] to [Company B] are detailed in Article 2 of the Agreement. They are in pertinent part as follows:

2.1 [Company C] grants to Thermal Cycler Supplier [Company B] under the PCR Instrument Patents and the Pressing Heated Cover Claims a personal, non-transferable, royalty-bearing, non-exclusive license in the Fields and in the Territory to make but not have made, to use and to sell thermal cyclers to end users under Thermal Cycler Supplier’s name and trademarks but not otherwise to sell or distribute to thermal cycler suppliers Sales may be by Thermal Cycler Supplier directly or through Affiliates or distributors.

2.2 [Company C] grants to Thermal Cycler Supplier the following personal, non-transferable, royalty-bearing, non-exclusive rights in the Territory under the Amplification Patent Rights:

Thermal Cycler Supplier is hereby authorized to sell and distribute to end users under Thermal Cycler Supplier’s name and trademarks thermal cyclers and temperature cycling instruments manufactured by Thermal Cycler Supplier, but not otherwise to sell or distribute to thermal cycler suppliers, with a label conveying to end users (including Thermal Cycler Supplier itself) in the Fields the up-front rights of PCR process licenses as specified in the label set forth in Section 5.1 below

5.1 Authorized Thermal Cycler This instrument, Serial No. ______, is an Authorized Thermal Cycler. Its purchase price includes the up-front fee component of a license under the patents on the Polymerase Chain Reaction (PCR) process, which are owned by [Company D and Company E], to practice the PCR process for internal research and development using this instrument. The running royalty component of that license may be purchased from [Company C] or obtained by purchasing Authorized Reagents. This instrument is also an Authorized Thermal Cycler for use with applications licenses available from [Company C]. Its use with Authorized Reagents also provides a limited PCR license in accordance with the label rights accompanying such reagents. Purchase of this product does not itself convey to the purchaser a complete license or right to perform the PCR process. Further information on purchasing licenses to practice the PCR process may be obtained by contacting the Director of Licensing at [Company C]. [Company C] does not guarantee the performance of this instrument.

, that is, with an Authorized Thermal Cycler label; and

Thermal Cycler Supplier may advertise and promote thermal cyclers and temperature cycling instruments so labeled as Authorized Thermal Cyclers for PCR.

The term “Fields” is defined in Section 1.6 to mean “research and development, quality assurance or control, environmental testing, plant diagnostics, identity testing (other than parentage testing for humans), and forensics.” “Territory” is defined in Section 1.10 to mean “worldwide.” In addition to the rights listed above the Agreement also confers an immunity from suit (Section 2.3) which has little or no bearing on the question of royalty dutiability.

Article 3 of the Agreement sets forth the royalties and associated fees that [Company B] is required to pay [Company C] for the license and authorization rights granted under Article 2. Section 3.1 provides in pertinent part for a one-time license issue fee of $100,000.00 and a per unit royalty payment of $300.00 plus seven percent (7%) of the Net Sales Price.

The term “Net Sales Price” is defined in Section 1.7 of the Agreement. It specifies in relevant part that the “Net Sales Price” for thermal cyclers distributed under the Agreement refers to the sales price charged to Third-Party end users. This means the gross invoice price less deductions where applicable for discounts and duties and certain taxes. With regard to sales to end users in North America, Net Sales Price shall be calculated using the list price in [Company A’s] published catalog as the gross invoice price, if available. Otherwise, in the event Thermal Cycler supplier is unable to account for end-user sales by any distributor, the Net Sales Price shall be calculated as the price to the final distributor multiplied by 1.67, which factor represents a 40% margin on sales to end users by the distributor. Section 1.9 defines “Third Party” as “a party other than the Parties [[Company C] and [Company B]] or an Affiliate of the Parties or a distributor of the Parties or an Affiliate.”

The per unit royalties are paid by [Company B] to [Company C] on a quarterly basis. To calculate the amounts due, [Company A] first issues a quarterly report to [Company B] of the number of units sold. [Company B] then issues an invoice to [Company A] covering the license fee due [Division C] for those units. [Company A] remits payment to [Company B], which then forwards the exact same amount to [Division C] in the United States. Counsel for [Company A] enclosed documentation illustrating these transactions.

ISSUE:

Whether the royalties and license payments made by [Company A] to [Company B] are part of or additions to the price actually paid or payable?

LAW AND ANALYSIS:

Merchandise imported into the United States is appraised in accordance with section 402 of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (TAA) codified at 19 U.S.C. § 1401a. The preferred method of appraisement under the TAA is transaction value, defined as “the price actually paid or payable for the merchandise when sold for exportation to the United States,” plus certain enumerated additions, including any royalty or license fees related to the imported merchandise that the buyer is required to pay as a condition of the sale for export to the United States; and the proceeds of any subsequent resale, disposal, or use of the imported merchandise that accrue, directly or indirectly, to the seller. 19 U.S.C. § 1401a(b)(1)(D)&(E). These additions apply only if they are not already included in the price actually paid or payable.

However, as you know, transaction value is an acceptable basis of appraisement only if, inter alia, the buyer and seller are not related, or if related, the relationship did not influence the price actually paid or payable, or the transaction value closely approximates certain “test values.” 19 U.S.C. § 1401a(b)(2)(B). In the instant case, the buyer and seller are related but no information has been presented as to whether the relationship influences the price actually paid or payable; consequently, we are unable to determine whether transaction value is an appropriate basis of appraisement. Nevertheless, assuming that transaction value is the appropriate basis of appraisement, the following constitutes our position in regard to the dutiability of the royalty payments at issue.

In regard to the dutiability of royalty payments and license fees, the Statement of Administrative Action (SAA), which forms part of the legislative history of the TAA, provides in relevant part:

Additions for royalties and license fees will be limited to those that the buyer is required to pay, directly or indirectly, as a condition of the sale of the imported merchandise for exportation to the United States. In this regard, royalties and license fees for patents covering processes to manufacture the imported merchandise will generally be dutiable, whereas royalties and license fees paid to third parties for use, in the United States, of copyrights and trademarks related to the imported merchandise, will generally be considered as selling expenses of the buyer and therefore will not be dutiable. However, the dutiable status of royalties and license fees paid by the buyer must be determined on a case-by-case basis and will ultimately depend on: (i) whether the buyer was required to pay them as a condition of sale of the imported merchandise for exportation to the United States; and (ii) to whom and under what circumstances were they paid. For example, if the buyer pays a third party for the right to use, in the United States, a trademark or copyright relating to the imported merchandise, and such payment was not a condition of the sale of the merchandise for exportation to the United States, such payment will not be added to the price actually paid or payable. However, if such payment was made by the buyer as a condition of sale of the merchandise for exportation to the United States, an addition will be made. As a further example, an addition will be made for any royalty or license fee paid by the buyer to the seller, unless the buyer can establish that such payment is distinct from the price actually paid or payable for the imported merchandise, and was not a condition of the sale of the imported merchandise for exportation to the United States.

Statement of Administrative Action, H.R. Doc. No. 153, 96 Cong., 1st Sess., pt 2, reprinted in, Department of the Treasury, Customs Valuation under the Trade Agreements Act of 1979 (October 1981), at 48-49.

As the language of the SAA makes clear, an addition will be made for any royalty or license fee paid by the buyer to the seller, unless the buyer can establish that such payment is distinct from the price actually paid or payable for the imported merchandise. The term “price actually paid or payable” is defined as “the total payment (whether direct or indirect) made, or to be made, by the buyer to, or for the benefit of, the seller.” 19 U.S.C. § 1401a(b)(4)(A). Thus the first inquiry is whether the payments at issue are part of the price actually paid or payable for the imported merchandise.

Based on Generra Sportswear Co. v. United States, 905 F.2d 377 (Fed. Cir. 1990), U.S. Customs and Border Protection (“CBP”) presumes that all payments made by the buyer to the seller are part of the price actually paid or payable for imported merchandise. In Generra, the Court of Appeals held that the term “total payment” is all-inclusive and that “as long as the quota payment was made to the seller in exchange for merchandise sold for export to the United States, the payment properly may be included in transaction value, even if the payment represents something other than the per se value of the goods.” The court also stated:

Congress did not intend for the Customs Service to engage in extensive fact-finding to determine whether separate charges, all resulting in payments to the seller in connection with the purchase of imported merchandise, are for the merchandise or for something else. As we said in Moss Mfg. Co. v. United States, 896 F.2d 535 (Fed. Cir. 1990), the “straightforward approach [of section 1401a(b)] is no doubt intended to enhance the efficiency of Customs’ appraisal procedure; it would be frustrated were we to parse the statutory language in the manner, and require Customs to engage in the formidable fact-finding task, envisioned by [appellant].

Generra, 905 F.2d at 380 (brackets in original).

The presumption that all payments made by the buyer to the seller are part of the price actually paid or payable may be rebutted, however. In Chrysler Corporation v. United States, 17 CIT 1049 (1993), the Court of International Trade applied the standard in Generra and determined that certain shortfall and special application fees which the buyer paid to the seller were not a component of the price actually paid or payable for the imported merchandise. The court found that the evidence established that these fees were independent and unrelated costs assessed because the buyer failed to purchase other products from the seller and were not a component of the price of the imported engines. Accordingly, the royalty payments at issue will not be considered part of the price actually paid or payable if the evidence clearly establishes that, like those in Chrysler, they are totally unrelated to the imported merchandise. The burden of establishing that the payments are totally unrelated to the imported merchandise rests with the importer. Generra, 905 F.2d at 380.

To briefly reiterate, the Agreement grants the seller [Company B] certain rights under various patents and patent applications, namely, to make, use and to sell thermal cyclers to end users, either directly or through its affiliates or distributors. [Company A] is identified in Section 1.7 of the Agreement as an affiliate of [Company B]. In addition, the Agreement grants [Company B] the right to sell and distribute those units under its own name and trademark, and to promote them as “Authorized Thermal Cyclers for PCR.” Finally, the Agreement gives [Company B] the authority to distribute the instruments with a label conveying to customers certain rights under the up-front fee component of the PCR licenses. [Company B] manufactures the thermal cyclers and sells them to [Company A], which in turn resells them to U.S. customers. [Company A] makes royalty payments to [Company B] on a quarterly basis, and [Company B] in turn remits royalty payments to the licensor, [Company C].

To rebut the presumption that the royalties paid by [Company A] to [Company B] are not part of the price actually paid or payable for the imported thermal cyclers, [Company A]’s counsel offers the following argument. In counsel’s view, the royalties are not properly included because 1) they are ultimately made to a U.S. patent holder and 2) they do not inure to the benefit of the seller. Counsel cites to Headquarters Ruling Letter (“HQ”) 542152, dated December 4, 1980, HQ 542818, dated May 27, 1982 and HQ 542926, dated January 21, 1983, in support of its position. The first two rulings involved situations where an importer made royalty payments to a U.S. patent holder that was unrelated to either the importer or the seller. In both cases the payments were found not to be a condition of the sale of the imported merchandise for exportation to the United States. In HQ 542926 it was determined that royalty payments made to a foreign seller that inure to the benefit of a U.S. patent holder were not a condition of the sale and, therefore, were non-dutiable.

We disagree with counsel’s view that the foregoing rulings help [Company A] overcome the presumption that their royalty payments to [Company B] are part of the price actually paid or payable. Most significantly, all three cited rulings predated Generra, and thus have little or no bearing on a price actually paid or payable discussion. Secondly, in HQ 542152 and HQ 542818 the royalty payments were not made to the seller and thus are irrelevant for purposes of analysis under Generra. Thirdly, the nationality or location of the patent holder is immaterial for purposes of determining if a royalty is dutiable. And finally, the question of whether or not a payment inures to the benefit of the seller is not part of the Generra test. [Company A] has not provided evidence that clearly establishes that the license payments are totally unrelated to the imported merchandise. It has thus failed to rebut the presumption under Generra that its royalty payments to [Company B] are part of the price actually paid or payable.

Although we have determined that the royalty payments made by [Company A] to [Company B] are part of the price actually paid or payable, we will also examine whether they are an addition to the price under 19 U.S.C. § 1401a(b)(1)(D) or (E). CBP has established a three-part test for determining the dutiability of royalty payments. This test appears in the General Notice, Dutiability of Royalty Payments, Vol. 27, No. 6 Cust. B. & Dec. at 1 (February 10, 1993) (“Hasbro II ruling”). The test consists of the following questions: 1) was the imported merchandise manufactured under patent; 2) was the royalty involved in the production or sale of the imported merchandise; and 3) could the importer buy the product without paying the fee? An affirmative answer to question 1 and 2 and a negative answer to question 3 points to dutiability. Question 3 goes to the heart of whether the payment is considered to be a condition of sale.

Despite counsel’s assertion to the contrary in its ruling request, our review of Section 2.1 of the Agreement clearly indicates that [Company B] manufactures the thermal cyclers under patent (“[Company C] grants to Thermal Cycler Supplier under the PCR Instrument Patents a license to make but not have made thermal cyclers ”). The answer to the first question is, therefore, in the affirmative. Similarly, the Agreement requires an affirmative response to Question 2. This is because Article 3 of the Agreement specifies that [Company B] shall pay royalties to [Company C] for the license and authorization rights granted under Article 2, and Section 2.1 grants [Company B] license rights to make and to sell thermal cyclers. The ensuing royalties are thus “involved in the production or sale of the imported merchandise.” We are not persuaded by counsel’s argument that the royalties relate solely to the thermal cyclers’ “designation, marketing and use as ‘Authorized Thermal Cyclers’ for purposes of conducting a PCR protocol.” This argument focuses solely on the labeling, marketing and promotion rights granted in Section 2.2 and completely ignores the production and sales rights granted in Section 2.1, rights which we should note [Company B] exercises. The unambiguous language in Articles 2 and 3 of the Agreement calls for affirmative responses to the first two questions of the three-part test described above.

The remaining question is whether [Company A] could buy the thermal cyclers without paying the royalty fee. In response to this question counsel maintains that the answer is “yes,” because its client could, and does, buy and import the product without paying the fee. The fee, counsel maintains, is related to the use of the product by third-party end users as “Authorized Thermal Cyclers,” and is based on, and only incurred, when the products are sold domestically to third-party end users. Accordingly, it is argued, the license fee is not a condition of the sale for export to the United States, but rather a condition of the domestic resale of the imported thermal cyclers as authorized models.

We disagree with [Company A]’s position on this matter. It is evident, upon examination of the Agreement, that the thermal cyclers will be manufactured, imported and subsequently resold only on the understanding or condition that the royalties are paid. In particular, we again make reference to Section 2.1 of the Agreement, which grants [Company B] the license under patent to make, use and sell thermal cyclers to end users under [Company B]’s name and trademarks, such sales being made directly by [Company B] or through its affiliates or distributors. In consideration for the exercise of these rights and the labeling, marketing, promotion and immunity rights outlined in Sections 2.2 and 2.3, [Company B] is required by Article 3 to pay a royalty to [Company C] upon resale of the thermal cyclers in the United States. Article 2.1 restricts [Company A], in its role as an affiliate, to reselling the thermal cyclers to end users in the United States. It cannot assume any of [Company B]’s other rights to make or use the thermal cyclers, because Article 2.5 of the Agreement prevents [Company B] from sublicensing, assigning or otherwise transferring or sharing its rights thereunder. Section 2.5 Rights granted to Thermal Cycler Supplier by this Agreement are personal to Thermal Cycler Supplier alone. Thermal Cycler Supplier shall have no right to sublicense, assign or otherwise transfer or share its rights hereunder. [Company A] thus imports the thermal cyclers with the full expectation that it will resell them and pay royalties to [Company B]. The fact that they will only become due upon resale to end users is immaterial in determining whether they are dutiable, a fact noted in the Hasbro II ruling, cited earlier. In that ruling, CBP noted that “the method of calculating the royalty, e.g., on the resale price of the goods, is not relevant to determining the dutiability of the royalty payment.” Vol. 27, No. 6 Cust. B. & Dec. at 12. See also HQ 545777, dated September 1, 1995, and HQ 545710, dated October 30, 1998. Thus, [Company A] cannot buy the thermal cyclers without paying the royalty. There is a clear, substantial nexus between the imported thermal cyclers, the patented technology, and the royalty payments.

Based on the foregoing considerations, we find that the royalties at issue relate to the imported merchandise and that [Company A] is required to pay them as a condition of the sale for exportation to the United States. Accordingly, we conclude that the royalty payments are additions to the price actually paid or payable under 19 U.S.C. § 1401a(b)(1)(D).

HOLDING:

Based on the information provided, the subject royalty payments are part of the
price actually paid or payable. Furthermore, they qualify as additions to the price actually paid or payable pursuant to 19 U.S.C. § 1401a(b)(1)(D).

Sincerely,

Monika R. Brenner
Chief

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